Tax reform 2017 – Can Republicans move beyond Trickle Down?

April 22, 2017

With the release of the Republicans’ new tax reform legislation imminent, I thought it might be a good time to revisit a Confronting Mediocrity post from 2010 titled, Top fractiles income share and the “good old days.” [1] The reasons for the renewed relevance of the post is that the Republicans’ new tax reform plan will inevitably have generous tax cuts for the wealthy while it will have minimal tax cuts for the working class. It will be the most recent attempt to put lipstick on the pig that is known variously as trickle down economics, supply-side economics, Reaganomics, or, as George H.W. Bush characterized it in 1980 – Voodoo economics.

Whatever shade of lipstick you put on the pig, it’s still a pig. Reaganomics didn’t work in the 1980s and a reincarnation of it will fail in 2017. The reason is the basic premise is flawed, unless the objective is to make the rich richer at the expense of throttling the economy. An oversimplification of the trickle down premise is that giving hefty tax cuts to the wealthy will incent them to build more factories and make more products thereby creating jobs for workers. Under this conceit, the economic benefit of a tax cut to the wealthy would trickle down to the working class.

Let be crystal clear about one thing. Trickle down economics simply does not work. It’s backwards. Henry Ford new that when he decided to double the minimum wage for his employees to $5.00 per day. And, it wasn’t a pay hike driven by altruism. In his 1926 book, Today and Tomorrow [2], Mr. Ford wrote,

“The owner, the employees, and the buying public are all one and the same, and unless an industry can so manage itself as to keep wages high and prices low it destroys itself, for otherwise it limits the number of its customers. One’s own employees ought to be one’s own best customers.”

It’s a simple concept, really. Put another $5,000 in the pocket of a millionaire through a tax break and what happens? Nothing, except maybe it’s invested in some equity fund. On the other hand, put $5,000 in the hand of a worker and what happens? He or she buys stuff. They consume, and the products they consume must be built by someone, so employment increases to build the products to meet the increased demand.

In 2012, the non-partisan Congressional Research Service published a study titled Taxes and the Economy: An Economic Analysis of the Top Tax Rates Since 1945. [3] A key paragraph from the report summarizes their findings by saying,

“The reduction in the top tax rates appears to be uncorrelated with saving, investment and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie. However, the top tax rate reductions appear to be associated with the increasing concentration of income at the top of the income distribution.”

This report was nothing less than a bombshell to the tenaciously-held core belief of Republicans that Ronald Regan’s trickle down philosophy was economic scripture. To acknowledge that trickle down may not work would be blasphemy, so Senate Majority Leader, Republican Mitch McConnell forced the report to be taken down. [4]

Then, in 2015, the International Monetary Fund published a paper, Causes and Consequences of Income Inequality: A Global Perspective [5], that effectively drove a stake of reality through the heart of the trickle down argument dismissing it as a fatally flawed principle and confirming what Henry Ford believed 90 years earlier. The report summarized their findings by stating,

“We find that increasing the income share of the poor and the middle class actually increases growth while a rising income share of the top 20 percent results in lower growth—that is, when the rich get richer, benefits do not trickle down.”

It seems that most now believe that the unequal distribution of incomes in the United States is a core issue that must be addressed. It is an issue that Democrats have been championing for decades and one that even some Republicans are begrudging acknowledging the impact of income disparity.

I will end this post where I began it by referencing the 2010 post in Confronting Mediocrity. The chart below was presented in that post and clearly demonstrates that as the top marginal tax rate decreased, the income disparity increased. And for that we can thank the failure of Regan’s trickle down economics.

The era of broad prosperity between 1947 and 1974 coincided with a high top marginal tax rate and a relatively evenly distributed income share.

So, in the coming weeks, be alert for Republicans proposing tax reform based on the premise that preferentially benefiting the wealthy would create jobs and spur the economy. That concept is now fully debunked. Q.E.D.